By Peter Biar Ajak, Director
Prior to the historic decision by the Council of Ministers to completely shut down the country’s oil production, oil revenues accounted for over 98% of the Republic South Sudan expenditures, 99% of foreign exchange earnings, and over 70% of South Sudan GDP. The 10 states of South Sudan depended on transfers from the Central Government for the bulk of their own expenditures. This post outlines macroeconomic impact of the shutdown and possible scenarios that may emerge.
The Effects on the Output (GDP)
The oil sector accounts for 71 percent of the GDP of South Sudan. The oil shutdown means a contraction of the economy by 71 percent. However, only very few South Sudanese are currently employed in the oil sector where most employees are either north Sudanese, Chinese, or Malaysians. The economy of South Sudan is largely divdided into two:
- Subsistence rural economy: Over 80 percent of South Sudanese are subsistence households, employed in Agriculture (crop farming and animal husbandry), and their economic activities are not directly affected by the oil sector on a daily basis.
- Oil fueled urban economy: The rest of the economy based in the urban areas is largely a cash economy, dependent on imports from the neighboring countries. Since the last census of 2008, people have migrated to the urban areas in waves since most of the Government’s budget was being consumed in the urban centers. Most people in the urban areas work for the government (Central of State Government), and the rest either work for private companies or depend on their employed relatives.
Aside from the 71 percent reduction in the output with the shutdown of the oil wells, other reduction in the GDP would occur with the reduction of the government expenditures. Many private companies in the urban areas depend on Government contracts for their profits. A reduction in the Government expenditures would directly translate to fewer contracts, reducing companies’ profits.
With decrease of its revenues by 98 percent, the Ministry of Finance & Economic Planning would necessarily have to cut expenditures. However, South Sudan in this case would not be able to live within its means, since its means consists of only less than 2 percent of its previous resources envelop, while the expenditures have not necessarily decreased overnight. In this case, the Ministry of Finance & Economic Planning (MoFEP) would have to manage its reserves (let’s call this figure Z billion) stringently while toiling to augment the revenue base. However, limiting our analysis to only the effects of the oil shutdown, the following may occur on the fiscal side:
- Maintain status quo: The Ministry of Finance & Economic Planning for political reasons, or whatever reason may decide to maintain the budgeted level of expenditures. The current expenditures of GOSS are north of SSP 850 million per month. This means that maintaining the status quo will cause MoFEP to deplete its reserves in [SSP Z Billion/SSP 850 million] months; call this figure K. As such, after K months, the Ministry of Finance & Economic Planning would run out of money, and the following may happen.
- Borrow fast and a lot: MoFEP on behalf of the Government can borrow from domestic and foreign sources to continue to finance its budget deficit. Avenues of credit are limited domestically and international capital markets are not looking promising given the ongoing debt crisis in the Euro Zone and similar issues in the United States. However, South Sudan may look to the Asian countries for credit, although the price on those loans would be quite expensive.
- Seigniorage Tax: The MoFEP and BOSS can print money to finance expenditures. This is often a form of tax on the users of money (consumers, retailers, etc). The printing of money would weaken the value of the SSP and may lead complications on the monetary side such as:
- Hyperinflation: Most hyperinflations have been caused when the Government increased the money supply without corresponding increase in the real output. Such an increase in the money supply results in the increasing price levels (often of over 50% per month) to the point where the currency lose total value and users lose faith in the currency and convert their assets into other mediums.
- Bank run: If economic actors know that the Government is going to print money, this means direct tax on their money unless if they quickly convert into other mediums. People will withdraw their savings in large numbers, causing massive failures of Banks, and convert their money to other forms from the SSP.
- Radically reduce Expenditures:Instead of living way beyond its means, the MoFEP can radically reduce current expenditures as it seeks other sources of funding. Even under this scenario, MoFEP would still be facing an imminent depletion of its reserves, unless if the cuts are deep enough to allow the reserves to last till the completion of the new pipeline. In any case, the reduction in the output could lead to the following:
- Reduced Output/Employment: The reduction of the government expenditures means decrease of public investment, which essential reduces output. It also means that the Government will be demanding fewer goods than it has previously done. Such a normal reduction in output would be exacerbated by reduction in the profits of the private sector, leading to possible layoffs.
- Reduced private investment: Once the Government investment is expected to decline, the private actors themselves will be hesitant to invest in the economy as the uncertain looms. People would prefer to hold on to their cash instead of taking risks that may take too long to pay off when prospects look dim. The reduction of the private and public investments will lead to recession.
The Bank of South Sudan (BOSS) relies on the holding of foreign exchange reserves to maintain the stability/value of the South Sudanese Pound (SSP). The sale of the crude oil used to provide BOSS with over 99 percent of its monthly foreign exchange earnings. The oil shutdown means that BOSS’s foreign exchange supply has diminished by 99 percent, and therefore very little additional foreign exchange will trickle into BOSS’s account. As such, BOSS is left with whatever reserves it has accumulated thus far (assume this values to be $X billion) to maintain the stability of the currency.
South Sudan’s economy largely relies on imports from its neighbors. The rural economy imports the manufactured goods such as salk, oil, and medicines, but produces its own food; while the urban economy virtually imports almost everything including vegetables. To purchase these imports, South Sudan needs foreign exchange since the SSP is a legal tender only within the jurisdiction of South Sudan, and the cross-border transactions necessarily take place in the currencies of the countries in which the goods are being produced. Assume that for a month of imports, South Sudan needs $Y million. With this knowledge and faced with the imminent depletion of its reserves, the BOSS may do one of the following:
- Maintain the status quo– Maintaining the current level of foreign exchange injection into the market will sustain the current level of imports. Prices would largely stay the same. However, the depletion of current reserves would continue until for [$X billion/$ Y million] months; let’s call it J months. After J months, BOSS would not have additional foreign exchange to allow for more imports. Such a scenario would lead to the following things could occur:
- A run on the Banks: In the months leading up to the complete depletion of reserves, rational actors will rush to convert their holding of Sudanese Pounds into hard currency. The rush for hard currency would produce a run on the Banks, where people will move to quickly convert their money into foreign exchange or assets whose value is considered stable. The SSP will become completely useless. Retailers and business will demand foreign currencies as the medium of exchange instead of the SSP.
- Increase in prices: With no more imports coming in, retailers will significantly increase the prices of the few goods they have on their shelves.
- Steadily reduce the injection of Foreign Exchange into the Market: Faced with the decreasing reserves, the BOSS could steadily reduce the injection of the foreign exchange into the market. Such a policy will allow for the little existing reserves ($X billion) to last for a much longer period, depending on the size of the reduction. However, the SSP will start to weaken since the supply of foreign currency has become scarce while the demand remains the same (or even higher due to psychological effects), unless the reduction of the SSP is complemented by a proportionate reduction in the supply of the SSP in the market. As the SSP falls, some of the following may start to occur:
- A depreciated exchange rate: The reduction of foreign exchange supply will result in weaker SSP, which essentially equates to the reduction of imports. As the supply of the imports decrease while the demand largely remain unchanged, the result is an increase in the equilibrium price. Likewise, rational actors will expect BOSS to run out of the supply of reserves sooner. As such, they may in rush to exchange their SSP into dollars before the reserves run out.
These monetary effects reciprocate one another, and much of the impact is often due to sequencing and the psychological reaction of the economic actors. The monetary side often reacts to events and signals from the fiscal side. The decisions by the Government on the fiscal side would also have consequences on the monetaryside.
As it can be seen, oil is the bloodline of the economy of South Sudan. The shutdown of the oil will have enormous consequences in the macro-stability of South Sudan’s economy. The output will fall by over 70 percent, causing a massive depression that could radically change the country. The management of the existing reserves by both BOSS and MoFEP will be crucial in surviving the crisis.